Looking for a GILTI-Free Structure? Try Estonia

Publication Date01 Apr 2019
Law FirmBilzin Sumberg
AuthorJeffrey L. Rubinger,Summer Ayers LePree

Estonia, the small Baltic country of just 1.3 million people situated halfway between Sweden and Russia, was named “the most advanced digital society in the world” by Wired magazine. According to recent figures, Estonian residents complete their taxes online in under five minutes, 99 percent of Estonia’s public services are available on the internet 24 hours a day, and nearly one-third of its citizens vote via the internet. With these advanced technological features, it is not surprising that its government boasts that Estonia is home to more tech unicorns (i.e., private companies valued at more than $1 billion) per capita than any other small country in the world.

As a result of the high number of technology companies that call Estonia home, one might think that the U.S.’s new global intangible low taxed income (or GILTI) tax was enacted specifically to go after U.S. taxpayers doing business in countries such as Estonia, where intangible assets presumably make up a significant portion of the value of these tech companies. The new GILTI regime, enacted as part of 2017 tax reform, generally triggers immediate U.S. tax on active income earned by a Controlled Foreign Corporation (CFC), other than an annual carve-out for 10 percent of the CFC’s adjusted basis in its tangible depreciable assets used in its trade or business. In essence, all active income above this assumed return is deemed to be from intangibles (regardless of any actual relationship to intangible assets), and is thus subject to the GILTI provisions, which now reach most offshore income that was previously possible to defer from U.S. taxation.

Despite GILTI’s apparent reach, however, and its intended impact of requiring immediate U.S. federal income tax recognition for almost all income earned by a CFC (specifically a CFC without sufficient high-basis tangible assets), Estonia’s tax system, coupled with a few key provisions in the U.S. tax rules, may afford U.S. taxpayers a unique opportunity to avoid immediate taxation under both the Subpart F income and GILTI rules, without paying any current foreign tax.

Estonian Corporate Tax System

The Estonian corporate tax system, which is no longer unique,[1] generally functions as follows. All undistributed corporate profits are exempt from taxation. This exemption covers both active (e.g., trading) and passive (e.g., dividends, interest, royalties) types of income, and also covers capital gains from the sale of any and all assets, including shares, securities, and immovable property. The taxation of corporate profits is postponed, typically until the profits are distributed as dividends. At the time of distribution, the 20 percent corporate income tax applies. For example, a company that has profits of 100 euros (EUR) available for distribution may distribute dividends of EUR 80, with the remaining EUR 20 being used to satisfy the Estonian corporation income tax of 20 percent. From the Estonian perspective, this tax is considered a corporate income tax and not a withholding tax, so the tax rate is not affected by applicable tax treaties. The tax system makes sense in the context of Estonia’s active start-up culture. It allows young, growing companies to maximize the use of cash to grow the business, requiring them to pay into the tax system only when they proceed to actually distribute profits to ownership.

Although the Estonian corporate tax is not payable until a distribution is made from the corporation, according to relevant Estonian tax principles, the corporate income tax arising from the payment of dividends is recognized as a liability and an income tax expense in the period the dividends are declared, regardless of the period for which the dividends are paid or the actual payment date.

Accrual of Foreign Taxes for Relevant US Purposes

For purposes of the high-tax exception to Subpart F income under Section 954(b)(4), the amount of foreign income taxes paid with respect to an item of income generally is the amount a taxpayer would be deemed to have paid under Section 960.[2] In order to determine the deemed-paid tax amount under Section 960, as a starting point, only foreign taxes that would be creditable are taken into account.[3]

For this purpose, Section 905(a) allows the accrual of foreign income taxes, even if the taxpayer generally uses the cash method of accounting, by election. A taxpayer exercising this election must usually continue to use this method for all subsequent years. A foreign income tax generally accrues under U.S. standards when the “all-events” test is met, which is the tax year in which all the events have occurred that establish the fact of the liability and permit the amount of the liability to be determined with reasonable accuracy. The economic performance test is not required to met with respect to the accrual of foreign taxes. Therefore, actual payment is not required in order for a creditable foreign tax liability to accrue for U.S. tax purposes.[4] Generally, the accrual...

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